Explanation of Commodity Pairs
Commodity pairs, often called commodity currencies, represent forex currency pairs from nations with extensive commodity reserves. The value of these pairs is strongly linked to the shifts in commodity prices, given these nations’ roles as producers and exporters of these commodities. Individuals looking to align their investments with commodity price movements sometimes trade these pairs, seeing them as an alternative to direct commodity investments.
Common examples of commodity pairs involve the U.S. dollar (USD) paired with the Canadian dollar (CAD), Australian dollar (AUD), or the New Zealand dollar (NZD). Additionally, the value of the Russian ruble (RUB), Brazilian real (BRL), and Saudi riyal (SAR) can be influenced by commodity price changes.
Comprehending the Role of Commodity Pairs
Investors often find commodity pairs advantageous due to their significant presence in the foreign exchange (FX) market. Engaging in forex trading means navigating the exchange rates of different currencies, aiming to benefit from favorable rate shifts. For instance, a trader based in the U.S. may buy the Australian dollar against the U.S. dollar rate (AUD/USD) at a current rate of 0.7500, signifying 75 U.S. cents for each Australian dollar. Should the rate increase to 0.8500, the trader could finalize an equivalent trade, thereby capturing the profit difference of 0.1000 cents (accounting for any associated transaction costs).
In the realm of forex, currencies are not physically exchanged. The conclusion of an equivalent trade ends the position, and the resultant profit or loss is reconciled within the trader’s brokerage account.
Market Liquidity of Commodity Pairs
The market associated with commodity pairs is notably liquid. A liquid market denotes a trading environment where transactions are easily carried out due to the abundance of both buyers and sellers. On the other hand, an illiquid market might hinder traders from efficiently closing positions due to insufficient market participation.
A factor enhancing the liquidity of commodity pairs is the robustness of their respective economies that support these currencies. These traits render commodity pairs favorable for traders desiring potential profit opportunities and swift trade executions.
Other Nations Rich in Commodities
While numerous countries boast significant reserves of natural resources and commodities, like Russia, Saudi Arabia, and Venezuela, the commodities from several countries tend to be either heavily overseen by their national governments or are not widely traded.
Primary Commodities and Their Influence on Currency Pairs
Three nations distinct from the U.S. play crucial roles in the trio of commodity-related currency pairs, each possessing particular attributes that render their currencies and commodity assets notable in the financial landscape.
Commodity prices, especially oil, strongly influence the Canadian and U.S. dollar (USD/CAD) relationship. With its expansive and largely untouched territories, Canada is abundant in natural assets like timber and fuel.
Canada’s economic structure significantly revolves around commodity production and trade. For instance, oil and fuels dominate its export portfolio. Consequently, the health of Canada’s economy is significantly influenced by oil prices.
Engaging in transactions involving this currency pair is colloquially called dealing with the “loonie.” The geographical closeness between Canada and the U.S. ensures their economic interdependence, evident from the fact that in 2019, 75% of Canada’s exports were to the U.S.
The Australian and U.S. dollar exchange rate is informally called the “Aussie” exchange. Australia holds the distinction of being the leading global exporter of coal and iron ore.
Furthermore, Australia boasts expansive green terrains and is one of the globe’s most resource-endowed nations. Consequently, commodities such as petroleum and gold are pivotal in shaping its currency’s value.
In addition to its commodity-centric nature, Australia’s economic patterns offer a glimpse into China’s economic performance, given that China is Australia’s primary export destination. A surge in Australia’s exports to China can be interpreted as a sign of robust economic activity in China, which has positive implications for global markets and can augment the value of the Australian dollar due to heightened demand for Australian products.
New Zealand is the premier global exporter of concentrated milk while shipping other dairy goods, meat, and wool.
A pronounced linkage exists between New Zealand and gold, leading to reactions in its currency with shifts in the gold price. Transactions involving the exchange between the New Zealand dollar and the U.S. dollar (NZD/USD) are often termed “kiwi” trades.
A factor amplifying the allure of the Kiwi is New Zealand’s tendency to offer interest rates that outpace those in numerous other nations. Hence, many investors channel their capital into New Zealand to benefit from these higher rates. Some even procure funds from nations with lower interest rates, like Japan, and redirect these funds (converted from Japanese yen) into NZD for investments in New Zealand’s banking sector.
This mechanism, where investments are financed by securing loans from countries with modest yields to invest in nations offering higher returns, is recognized as the currency carry trade.